Exercise 3

ALBELLI Ltd received a special one-time order for photo material. ALBELLI has excess capacity and can produce the special order while fulfilling the normal production as well. The order consists of 500 pieces with a selling price of 65 / piece. The machines for producing the special order have a book value of 2 000 and have no further use for ALBELLI. If the order is rejected these machines will be sold immediately at 1 500. If the order is accepted, these machines will be sold over three months at 800. If the order is accepted, additional storage is necessary. Storage is partly available already within the firm itself (the depreciation cost equals 12 000). Additional storage can be rented at 18 000 for the whole period of producing the special order.

To produce the special order, the following production costs per piece are estimated:

Direct Material 10

Direct Labor 6 (DL has no fixed contract & is paid on an as-needed basis)

Variable indirect costs 6

Allocated central fixed costs 8

Alternatively, ALBELLI could purchase the special photo material with an external supplier as well. The purchase price is 24 / piece. In case of outsourcing, ALBELLI will not make use of the machines, but the additional storage remains necessary.

Concerning the normal production of ALBELLI, the table below presents the unit prices and costs.

Selling price 70

Direct Material 17

Direct Labor 10 (DL has no fixed contract & is paid on an as-needed basis)

Variable indirect costs 8

Allocated central fixed costs 15

REQUIRED

1a. Is it interesting for ALBELLI to accept the special order? Is it more interesting to outsource the production of the special photo material, or to produce it in-house? The time value of money can be ignored.

1b. Besides the direct financial considerations, which non-financial considerations would you take into account?

1c. Suppose that ALBELLI is confronted with a flood and restricted production capacity. Suppose that the production of the special order would cause a decrease of the normal production with 100 pieces. Answer question 1a. using this additional information.